December 4, 2013
Interviewed by: Privcap
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Making the Real Estate Grade with Franklin Templeton

Franklin Templeton Real Asset Advisors invests with less than 10 emerging managers each year. In this video, Jack Foster, head of the group, talks about what he’s looking for in new commitments.

Franklin Templeton Real Asset Advisors invests with less than 10 emerging managers each year. In this video, Jack Foster, head of the group, talks about what he’s looking for in new commitments.

Making the Real Estate Grade with Franklin Templeton

With Jack Foster of Franklin Templeton Real Asset Advisors

Zoe Hughes, PrivcapRE:

I am joined here today by Jack Foster of Franklin Templeton Real Asset Advisors. Welcome to PrivcapRE.

Jack Foster, Franklin Templeton Real Asset Advisors:

Thank you very much for having me.

Hughes: It’s a pleasure. As we know, Franklin Templeton is a bigger investor in terms of smaller and emerging managers. Why you are looking at the smaller end of the spectrum, in terms of your investments as a multi-manager in commercial real estate?

Foster: We always have. Our history of investing in property, both for domestic and global markets, goes back over three decades, when most of the managers were emerging. We have a long history of working with emerging managers—working through terms, construction of how the structure should look legally and importantly, as when we look at smaller to medium-sized mangers and emerging managers today, there is a great ability to negotiate terms. That negotiation is simply creating a higher alignment of interest. As I say to my children, the larger funds say to us, “You get what you get and you don’t get upset.” We like to create a higher alignment of interest and we can do that with smaller managers as well as emerging managers.

Hughes: What type of opportunities are you looking for when you looked the smaller and more emerging managers? Is it very specific? Is it more niche? Or, are you looking for a broader arrangement?

Foster: It can be across both spectrums today why we are fortunate and investors are fortunate. The number of emerging managers, the profile has changed dramatically. Coming out of the global financial crisis, many funds have had challenges. We have seen a break-out of team members; many experienced team members have launched their own funds. We see opportunities with really experienced managers. In that way, we may look at a regional focus or—in some cases—a broad, specific city focus or a property-type focus, which is rare. We like to do diversified property strategies with specific emerging managers because they have room to move, depending on the changes and opportunities, sets and cycles. We look across all areas and can be very specific or, in some cases, emerging managers in Asia may go across several countries.

Hughes: You mention the opportunities presented to investors, yet 65% of LP’s would say “No, I will never look at a first-time fund.” Are you shocked by the figure or unsurprised?

Foster: I am absolutely not surprised, because we are in a unique position: we have been investing in funds for many years. Our team is dedicated. It takes significant resources to do deep dives on managers, whether existing or emerging. We have the ability to do those deep dives; many investors would rather come in later, after things have been stabilized and certain investors have invested—it makes the process easier. Thinking about how much currency you have as a portfolio manager within your organization, you might want to save the currency for things that go wrong. We are fortunate to have the team and the currency to do the deep dives and understand what it means to invest with emerging managers.

Hughes: What should investing with a smaller, more emerging manager do for your portfolio? Is it about diversification? Are you future-proofing your portfolio?

Foster: There are many different factors. First is creating that alignment of interest: because you are investing for the long-term and liquidity is an issue, it is important to ensure the manager you work with will be aligned with you over time. For instance, we sometimes look at the personal bank accounts of the mangers or key people to ensure an alignment of interest. But, as has been demonstrated in other asset classes, smaller emerging mangers can be more nimble and exploit inefficiencies in asset classes that are less liquid or less sufficient. So, exploiting inefficiency is very important when we look at managers. In core real estate, exploiting inefficiencies is less important, but as you move up the risk curve, being able to exploit inefficiencies is important. Those smaller emerging managers often play in niched areas where they can do that more. So, we can add significantly to the returns we see in our portfolios. It is not always the case, but it is an opportunity in selecting emerging managers.

Hughes: There is a huge debate on this: in 10 seconds or less, how do you define an emerging manager?

Foster: Very simplistically: a billion or less under management and no more than two to three funds. But the definition varies from client to client and situation to situation.

Hughes: When you look at a manager, what is the due-diligence process? What do they need to do in order to get an interview with Franklin Templeton?

Foster: We talk to everyone—that is where you start. It is important to meet with as many managers as possible because there is no benchmark. If you are making an opportunity cost decision to invest in one manager over others, you want to see as many managers as possible. It’s a very important part of what we do. Getting an interview with us is not difficult. Getting capital maybe a bit more challenging. So, we want to talk with everyone. We look at three basic things: strategy, experience, and the right governing or legal structure. ESG, Environmental Social Governance, is becoming more important for our clients. We look at those things, especially in emerging markets, where risks to clients profiles can be more important if there is a problem. We begin there and then there are a number of things we dive into. Your biggest risk is not necessarily the market opportunity, it is who your partner is in those markets. This is something we must focus on. We spend a great deal of time with the manager, understanding how they think. We love meeting with junior people on teams because we get insight that we may not see in other areas. Our managers are sharing a bit more with their junior people. It’s important to look at the fund across not just the legal structure and negotiating terms, but understanding the people, their commitment to the business longer term.

Hughes: Are there any less quantifiable characteristics you look for? Something a bit more subjective?

Foster: Yes, we like to make sure they enjoy themselves. We ask that question, “How do you operate and treat junior people? Is there room for succession in the organization? How are you thinking about sharing profits and proceeds?” FedEx said it well, “People first, then the clients will be taken care of.” Our employees first and our clients will be taken care of. We look for that in organizations. Are they taking care of their team members?

Hughes: Obviously, it is not just the strategies you look at but also structures. Is Franklin considering looking more at the co-investment and joint venture side, as well as fund investing, when you look at smaller and more emerging managers?

Foster: We want to see that an emerging manager can run the breadth of what it takes to work with institutions. The idea of jumping for an emerging manager and a co-investment can be attractive but it is also helpful for an emerging manager to have gone through the full investment process, of working with a co-mingled portfolio and working with clients. It is often a large leap for an emerging manager to move to an institutional level. Many emerging managers have focused on retail and retail investors, which are helpful for building track records, but there is a move to an institutional level in terms of service, reporting, costs, and so forth. We have certainly invested with emerging managers early in their focus. The co-investment in JV’s can be opportunities but, again, we often will look that there are a number of investors participating in any opportunity. The idea that an investment manager has been through the whole process of what it is to run a fund and work with institutions is very important to us.

Hughes: Are a lot of the managers that come through your door able to step up from that small, operating-partner basis into the real-estate investment manager in that fiduciary?

Foster: In the U.S., for instance, our hit rate, our deal flow of transactions available ranges anywhere for any given year funds open and close from 250 to 400 different opportunities. I am just talking about the U.S. Our investment rate per year is well below 10 funds a year. There are a number of funds we decide not to invest in; some of those may be qualified, but there are funds that we decide, at least short-term, are not appropriate for our clients.

Hughes: Looking more widely at the equity out there for smaller and emerging managers, is the institutional investor market perhaps missing a trick in terms of investing in the smaller end of the spectrum?

Foster: Investors coming through the global financial crisis are looking for returns again. There was a real pull-back on risk, especially liquid areas, but now the denominator for effect has been positive, bond markets and equity portfolios are up, so allocations for real estate are increasing. We see more and more investors looking at the opportunity of smaller managers. One reason is the number of offers has declined; many players that were very large prior to the global financial crisis have disappeared, so more investors are looking more broadly. We see more and more investors looking at the emerging manager’s space.

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